Cement industry's 1QFY17 performance was strong and exceeded our estimates on operating front mainly on account of better-than-expected reduction in operating costs mainly led by sharp fall in Power & Fuel costs (down by 23% yoy & 7% qoq on per tonne basis). Though demand environment softened on sequentially, it grew moderately on yoy basis, as the companies under our coverage universe recorded an average sales volume growth of ~6% yoy. Operating cost/tonne dipped by ~7% yoy mainly aided by ~23% fall in Power & Fuel costs/tonne. An increased usage of petcoke by many companies along with low-cost petcoke inventory led to sharp decline in fuel costs. However, dismal realization - barring Northern and UP markets - was a setback for most of the companies, which arrested margin expansion. Average realizations remained broadly flat on yoy basis, whereas it surged by ~4% qoq mainly aided by strong realization recovery in Northern markets. Companies operating in Northern markets i.e. Shree Cement & JK Lakshmi Cement recorded better sales growth. Ramco Cements, Mangalam Cement, ACC and UltraTech saw maximum savings in operating cost/tonne in the range of ~8-17% yoy owing to increased usage of petcoke and improving operating synergies. UltraTech, Shree Cement & Ramco Cements recorded a better-than-average EBITDA/tonne at Rs1,039, Rs1,262 & Rs1,265, respectively owing to their cost leadership. Given the favourable pricing environment and price recovery in the Southern markets, we expect the companies' performance to remain healthy in ensuing quarter. However, visible hardening of fuel costs might arrest margins expansion.

Outlook & Valuation

Though demand growth improved by strong ~9-10% in 4QFY16, it softened in 1QFY17 mainly on account of moderation in non-trade sales and absence of rural demand. However, demand was moderately higher than last year and is expected to grow by ~5-6% yoy in FY17E mainly to be supported by improvement in rural consumption due to favourable monsoon and continued traction in Roads & Highway and other key infra segments. Moreover, we continue to believe that the demand from Project Segment will bounce back post monsoon in FY17E with pick-up in construction activities especially from projects pertaining to concrete road, urban infrastructure and irrigation. We foresee an uptick in demand scenario on the backdrop of expected pick-up in construction activities especially from projects awarded in last 12-18 months. However, delay in demand recovery in Southern region will pose a challenge to the industry. Notably, slower capacity addition and incremental demand from proposed "Smart Cities" project & "Housing for All" scheme are likely to aid utilizations of the industry and hence profitability in the long-term. We firmly believe that cement industry is a perfect play of infrastructure boost in India owing to better balance-sheet of cement companies and improving return ratios. At the CMPs, we maintain our positive stance on UltraTech Cement in Large-cap space, while in Mid-cap space we prefer J.K. Cement, Ramco Cements Cement & Mangalam Cement.

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